276716461359643824397327125510730001817760--12-312021Q3000013627887255418090.100.050.601.731P1Y3322false0001817760us-gaap:AdditionalPaidInCapitalMember2020-07-012020-09-300001817760us-gaap:AdditionalPaidInCapitalMember2020-01-012020-09-300001817760us-gaap:CommonStockMember2020-07-012020-09-300001817760us-gaap:CommonStockMember2021-07-012021-09-300001817760us-gaap:CommonStockMember2020-01-012020-09-300001817760us-gaap:RetainedEarningsMember2021-09-300001817760us-gaap:AdditionalPaidInCapitalMember2021-09-300001817760us-gaap:AccumulatedOtherComprehensiveIncomeMember2021-09-300001817760us-gaap:RetainedEarningsMember2021-06-300001817760us-gaap:AdditionalPaidInCapitalMember2021-06-300001817760us-gaap:AccumulatedOtherComprehensiveIncomeMember2021-06-3000018177602021-06-300001817760us-gaap:RetainedEarningsMember2020-12-310001817760us-gaap:AdditionalPaidInCapitalMember2020-12-310001817760us-gaap:AccumulatedOtherComprehensiveIncomeMember2020-12-310001817760us-gaap:RetainedEarningsMember2020-09-300001817760us-gaap:AdditionalPaidInCapitalMember2020-09-300001817760us-gaap:AccumulatedOtherComprehensiveIncomeMember2020-09-300001817760us-gaap:RetainedEarningsMember2020-06-300001817760us-gaap:AdditionalPaidInCapitalMember2020-06-300001817760us-gaap:AccumulatedOtherComprehensiveIncomeMember2020-06-3000018177602020-06-300001817760us-gaap:RetainedEarningsMember2019-12-310001817760us-gaap:AdditionalPaidInCapitalMember2019-12-310001817760us-gaap:AccumulatedOtherComprehensiveIncomeMember2019-12-310001817760us-gaap:CommonStockMember2021-09-300001817760us-gaap:CommonStockMember2021-06-300001817760us-gaap:CommonStockMember2020-12-310001817760us-gaap:CommonStockMember2020-09-300001817760us-gaap:CommonStockMember2020-06-300001817760us-gaap:CommonStockMember2019-12-3100018177602020-01-012020-12-310001817760us-gaap:EmployeeStockOptionMembercik0001817760:ExercisePriceRangeTwoMember2021-02-282021-02-280001817760us-gaap:EmployeeStockOptionMembercik0001817760:ExercisePriceRangeOneMember2021-02-282021-02-280001817760us-gaap:EmployeeStockOptionMembercik0001817760:EquityIncentivePlan2021Member2021-02-282021-02-280001817760cik0001817760:EquityIncentivePlan2021Member2021-02-232021-02-230001817760cik0001817760:EmployeesAndConsultantsMemberus-gaap:EmployeeStockOptionMember2020-01-012020-09-300001817760us-gaap:EmployeeStockOptionMembercik0001817760:InvestmentAgreementForOptionsIssueMember2018-12-140001817760us-gaap:EmployeeStockOptionMembercik0001817760:InvestmentAgreementForOptionsIssueMember2014-07-150001817760srt:MinimumMember2021-01-012021-09-300001817760srt:MaximumMember2021-01-012021-09-300001817760us-gaap:EmployeeStockOptionMember2021-02-282021-02-280001817760us-gaap:EmployeeStockOptionMembercik0001817760:InvestmentAgreementForOptionsIssueMember2021-01-012021-09-300001817760cik0001817760:EmployeesDirectorsAndConsultantsMemberus-gaap:EmployeeStockOptionMember2021-01-012021-09-300001817760cik0001817760:ConsultingServicesMemberus-gaap:ImmediateFamilyMemberOfManagementOrPrincipalOwnerMember2021-07-012021-09-300001817760cik0001817760:SecuritiesExchangeAgreementMemberus-gaap:PrincipalOwnerMember2021-01-012021-09-300001817760cik0001817760:ConsultingServicesMemberus-gaap:ImmediateFamilyMemberOfManagementOrPrincipalOwnerMember2021-01-012021-09-300001817760cik0001817760:SecuritiesExchangeAgreementMemberus-gaap:PrincipalOwnerMember2021-07-012021-09-300001817760us-gaap:SoftwareDevelopmentMember2021-09-300001817760us-gaap:MachineryAndEquipmentMember2021-09-300001817760us-gaap:FurnitureAndFixturesMember2021-09-300001817760us-gaap:SoftwareDevelopmentMember2020-12-310001817760us-gaap:MachineryAndEquipmentMember2020-12-310001817760us-gaap:FurnitureAndFixturesMember2020-12-310001817760us-gaap:AccumulatedOtherComprehensiveIncomeMember2021-07-012021-09-300001817760us-gaap:AccumulatedOtherComprehensiveIncomeMember2021-01-012021-09-300001817760us-gaap:AccumulatedOtherComprehensiveIncomeMember2020-07-012020-09-300001817760us-gaap:AccumulatedOtherComprehensiveIncomeMember2020-01-012020-09-300001817760cik0001817760:TermLoanFacilityAgreementMember2020-12-310001817760cik0001817760:TermLoanFacilityAgreementMember2020-09-300001817760us-gaap:RetainedEarningsMember2021-07-012021-09-300001817760us-gaap:RetainedEarningsMember2021-01-012021-09-300001817760us-gaap:RetainedEarningsMember2020-07-012020-09-300001817760us-gaap:RetainedEarningsMember2020-01-012020-09-300001817760srt:MinimumMember2021-09-300001817760srt:MaximumMember2021-09-300001817760cik0001817760:TermLoanFacilityAgreementMember2021-07-012021-09-300001817760cik0001817760:TermLoanFacilityAgreementMember2021-01-012021-09-300001817760cik0001817760:TermLoanFacilityAgreementMember2020-07-012020-09-300001817760cik0001817760:TermLoanFacilityAgreementMember2020-01-012020-09-300001817760cik0001817760:SecuritiesExchangeAgreementMemberus-gaap:PrincipalOwnerMember2021-09-300001817760cik0001817760:ConsultingServicesMemberus-gaap:ImmediateFamilyMemberOfManagementOrPrincipalOwnerMember2021-09-300001817760us-gaap:AccountsPayableAndAccruedLiabilitiesMember2021-09-300001817760us-gaap:AccountsPayableAndAccruedLiabilitiesMember2020-12-310001817760us-gaap:ResearchAndDevelopmentExpenseMember2020-07-012020-09-300001817760us-gaap:SellingGeneralAndAdministrativeExpensesMember2020-01-012020-09-300001817760us-gaap:ResearchAndDevelopmentExpenseMember2020-01-012020-09-300001817760cik0001817760:TermLoanFacilityAgreementMember2021-01-262021-01-260001817760cik0001817760:TermLoanFacilityAgreementMember2021-09-300001817760cik0001817760:Octopus2019EfAndOtherNotesMember2019-06-260001817760cik0001817760:Octopus2018InvestmentLimitedNotesMember2018-07-200001817760cik0001817760:Basf2018VentureCapitalAndEntrepreneursFundL.p.NotesMember2018-04-180001817760cik0001817760:PubliclyTradedMarketMembercik0001817760:Octopus2019EfAndOtherNotesMember2019-06-262019-06-2600018177602020-01-240001817760cik0001817760:PreFundedWarrantsMember2021-02-230001817760cik0001817760:CommonStockWarrantsMember2021-02-2300018177602020-09-3000018177602019-12-310001817760us-gaap:WarrantMember2021-01-012021-09-300001817760us-gaap:EmployeeStockOptionMember2021-01-012021-09-300001817760us-gaap:EmployeeStockOptionMember2020-01-012020-09-300001817760us-gaap:SellingGeneralAndAdministrativeExpensesMember2021-07-012021-09-300001817760us-gaap:ResearchAndDevelopmentExpenseMember2021-07-012021-09-300001817760us-gaap:SellingGeneralAndAdministrativeExpensesMember2021-01-012021-09-300001817760us-gaap:ResearchAndDevelopmentExpenseMember2021-01-012021-09-300001817760us-gaap:AdditionalPaidInCapitalMember2021-07-012021-09-3000018177602021-11-110001817760us-gaap:AdditionalPaidInCapitalMember2021-01-012021-09-300001817760cik0001817760:PreFundedWarrantsMember2021-07-012021-09-300001817760cik0001817760:PreFundedWarrantsMember2021-02-232021-02-230001817760cik0001817760:CommonStockWarrantsMember2021-02-232021-02-230001817760cik0001817760:CommonStockWarrantsMember2020-01-012020-09-300001817760cik0001817760:SecuritiesExchangeAgreementSmartkemLimitedMember2021-02-230001817760cik0001817760:SecuritiesExchangeAgreementSmartkemLimitedMember2021-02-232021-02-230001817760cik0001817760:EquityIncentivePlan2021Member2021-02-230001817760us-gaap:CommonStockMember2021-01-012021-09-300001817760us-gaap:SellingGeneralAndAdministrativeExpensesMember2020-07-012020-09-300001817760cik0001817760:TermLoanFacilityAgreementMember2021-01-2600018177602021-07-012021-09-3000018177602020-07-012020-09-300001817760cik0001817760:Octopus2019EfAndOtherNotesMember2019-09-232019-09-230001817760cik0001817760:Octopus2019EfAndOtherNotesMember2019-06-262019-06-260001817760cik0001817760:Octopus2018InvestmentLimitedNotesMember2018-12-282018-12-280001817760cik0001817760:Basf2018VentureCapitalAndEntrepreneursFundL.p.NotesMember2018-12-282018-12-280001817760cik0001817760:Octopus2018InvestmentLimitedNotesMember2018-07-202018-07-200001817760cik0001817760:Basf2018VentureCapitalAndEntrepreneursFundL.p.NotesMember2018-07-202018-07-200001817760cik0001817760:Basf2018VentureCapitalAndEntrepreneursFundL.p.NotesMember2018-04-182018-04-1800018177602020-01-012020-09-3000018177602020-01-242020-01-240001817760cik0001817760:PreFundedWarrantsMember2021-09-300001817760cik0001817760:CommonStockWarrantsMember2021-01-012021-09-300001817760cik0001817760:CommonStockWarrantsMember2021-09-300001817760cik0001817760:CommonStockWarrantsMember2021-07-012021-09-300001817760cik0001817760:PreFundedWarrantsMember2021-01-012021-09-3000018177602021-01-012021-09-300001817760us-gaap:CommonClassAMembercik0001817760:SecuritiesExchangeAgreementSmartkemLimitedMember2021-02-232021-02-2300018177602021-09-3000018177602020-12-31iso4217:USDxbrli:pureiso4217:USDxbrli:sharesxbrli:sharescik0001817760:Votecik0001817760:tranchecik0001817760:patentcik0001817760:segment

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2021

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number: 000-56181

SmartKem, Inc.

(Exact name of registrant as specified in its charter)

Delaware

    

85-1083654

(State or other jurisdiction of

(I.R.S. Employer

incorporation or organization)

Identification Number)

Manchester Technology Centre, Hexagon Tower.

Delaunays Road, Blackley

Manchester, M9 8GQ U.K.

(Address of Principal Executive Offices)

011-44-161-721-1514

(Registrant’s telephone number)

Securities registered pursuant to Section 12(b) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes    No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes    No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes    No  

As of November 11 2021, there were 25,541,809 of the registrant’s shares of common stock outstanding.

Table of Contents

TABLE OF CONTENTS

Page

Part I

Financial Information

Item 1.

Financial Statements

3

Condensed Consolidated Balance Sheets as of September 30, 2021 and December 31, 2020

3

Condensed Consolidated Statements of Operations and Comprehensive Loss for the three and nine months ended September 30, 2021 and 2020

4

Condensed Consolidated Statements of Stockholders’ Equity for the three and nine months ended September 30, 2021 and 2020

5

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2021 and 2020

7

Notes to the Unaudited Condensed Consolidated Financial Statements

8

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

29

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

40

Item 4.

Controls and Procedures

41

Part II

Other Information

Item 1.

Legal Proceedings

42

Item 1A.

Risk Factors

42

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

58

Item 3.

Defaults Upon Senior Securities

59

Item 4.

Mine Safety Disclosures

59

Item 5.

Other Information

59

Item 6.

Exhibits

59

Exhibit Index

60

Signatures

61

2

Table of Contents

PART I —FINANCIAL INFORMATION

Item 1. Financial Statements

SMARTKEM, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets (Unaudited)

(in thousands, except number of shares and per share data)

September 30, 

December 31, 

    

2021

    

2020

ASSETS

 

  

 

  

Current assets:

 

  

 

  

Cash and cash equivalents

$

14,719

$

764

Accounts receivable

 

 

18

Research and development tax credit receivable

 

921

 

982

Prepaid expenses and other current assets

 

937

 

259

Total current assets

 

16,577

 

2,023

Property, plant equipment, net of accumulated depreciation of $1,041 and $908

 

805

 

682

Right-of-use assets, net

 

170

 

236

Other assets

 

6

 

8

Total assets

$

17,558

$

2,949

LIABILITIES AND STOCKHOLDERS' EQUITY

 

  

 

  

Accounts payable and accrued expenses

$

1,323

$

861

Current lease liabilities

 

125

 

217

Total current liabilities

 

1,448

 

1,078

Non-current lease liabilities

 

16

 

20

Total liabilities

 

1,464

 

1,098

Stockholders’ Equity:

 

  

 

  

Common stock, par value $0.0001 per share, 300,000,000 shares authorized, 25,541,809 and 13,627,887 shares issued and outstanding, at September 30, 2021 and December 31, 2020, respectively*

 

3

 

1

Additional paid-in capital

 

89,831

 

61,276

Accumulated other comprehensive loss

 

(1,365)

 

(1,480)

Accumulated deficit

 

(72,375)

 

(57,946)

Total Stockholders’ equity

 

16,094

 

1,851

Total Liabilities and Stockholders’ Equity

$

17,558

$

2,949

*

Please refer to Note 1

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

3

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited)

(in thousands, except number of shares and per share data)

Three Months Ended September 30, 

Nine Months Ended September 30, 

    

2021

    

2020

    

2021

    

2020

Revenue

$

$

50

$

$

71

Cost of revenue

 

 

26

 

 

38

Gross profit

 

 

24

 

 

33

Other operating income

 

447

 

747

 

1,135

 

1,125

Operating Expenses:

 

  

 

  

 

  

 

  

Research and development

 

1,356

 

1,102

 

6,725

 

3,213

Selling, general and administrative

 

1,368

 

292

 

6,695

 

1,061

Transaction expenses

 

 

 

1,329

 

Total operating expenses

 

2,724

 

1,394

 

14,749

 

4,274

Loss from operations

 

(2,277)

 

(623)

 

(13,614)

 

(3,116)

Non-operating (Expense)/Income

 

  

 

  

 

  

 

  

(Loss)/Gain on foreign currency transactions

 

(386)

 

1

 

(799)

 

Interest expense

 

 

 

(19)

 

(6,835)

Interest income

 

1

 

 

3

 

3

Change in fair value of derivative asset

 

 

 

 

(6,282)

Loss on conversion of convertible notes payable

 

 

 

 

(5,470)

Total non-operating (expense)/income

 

(385)

 

1

 

(815)

 

(18,584)

Loss before income taxes

 

(2,662)

 

(622)

 

(14,429)

 

(21,700)

Income tax expense

 

 

 

 

Net loss

$

(2,662)

$

(622)

$

(14,429)

$

(21,700)

Net loss

$

(2,662)

$

(622)

$

(14,429)

$

(21,700)

Other comprehensive loss:

 

  

 

  

 

  

 

  

Foreign currency translation

 

82

 

156

 

115

 

(405)

Total comprehensive loss

$

(2,580)

$

(466)

$

(14,314)

$

(22,105)

Basic & diluted net loss per common share

$

(0.10)

$

(0.05)

$

(0.59)

$

(1.73)

Basic & diluted weighted average shares outstanding

27,671,646

13,596,438

24,397,327

12,551,073

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

4

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholders’ Equity (Unaudited)

For the Three Months Ended September 30,

(in thousands, except share data)

Accumulated

Additional

Other

Common stock

Paid-in

Comprehensive

Accumulated

Stockholders’

    

Shares

    

Amount

    

Capital

    

Loss

    

Deficit

    

 Equity (Deficit)

Balance at June 30, 2020

13,447,057

1

60,963

(1,757)

(55,891)

3,316

Issuance of common stock

 

180,830

 

-

 

313

 

-

 

-

 

313

Foreign currency translation adjustment

-

-

-

156

-

156

Net loss

-

-

-

-

(622)

(622)

Balance at September 30, 2020

 

13,627,887

$

1

$

61,276

$

(1,601)

$

(56,513)

$

3,163

Accumulated

Additional

Other

Common stock

Paid-in

Comprehensive

Accumulated

Stockholders’

    

Shares

    

Amount

    

Capital

    

Loss

    

Deficit

    

 Equity (Deficit)

Balance at June 30, 2021

25,462,000

3

89,722

(1,447)

(69,713)

18,565

Stock-based compensation expense

-

-

2

-

-

2

Issuance of common shares to vendor

60,000

-

107

-

-

107

Stock options exercised

19,809

-

-

-

-

-

Foreign currency translation adjustment

-

-

-

82

-

82

Net loss

-

-

-

-

(2,662)

(2,662)

Balance at September 30, 2021

25,541,809

$

3

$

89,831

$

(1,365)

$

(72,375)

$

16,094

(continued)

5

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholders’ Equity (Unaudited) (Continued)

For the Nine Months Ended September 30,

(in thousands, except share data)

Accumulated

Additional

Other

Common stock

Paid-in

Comprehensive

Accumulated

Stockholders’

    

Shares

    

Amount

    

Capital

    

Loss

    

Deficit

    

 Equity (Deficit)

Balance at January 1, 2020

 

2,183,885

$

-

$

30,926

$

(1,196)

$

(34,813)

$

(5,083)

Issuance of common stock

 

2,548,877

 

-

 

4,592

 

-

 

-

 

4,592

Conversion of notes and interest

 

8,895,125

 

1

 

25,758

 

-

 

-

 

25,759

Foreign currency translation adjustment

 

-

 

-

 

-

 

(405)

 

-

 

(405)

Net loss

 

-

 

-

 

-

 

-

 

(21,700)

 

(21,700)

Balance at September 30, 2020

13,627,887

1

61,276

(1,601)

(56,513)

3,163

Accumulated

Additional

Other

Common stock

Paid-in

Comprehensive

Accumulated

Stockholders’

    

Shares

    

Amount

    

Capital

    

Loss

    

Deficit

    

 Equity (Deficit)

Balance at January 1, 2021

13,627,887

$

1

$

61,276

$

(1,480)

$

(57,946)

$

1,851

Issuance of common shares due to exercise of stock-options

 

1,424,622

 

1

 

19

 

-

 

-

 

20

Stock-based compensation expense

 

-

 

-

 

6,097

 

-

 

-

 

6,097

Repurchase of common stock

 

(2,307,700)

 

-

 

-

 

-

 

-

 

-

Effect of reverse capitalization

 

2,500,000

 

-

 

-

 

-

 

-

 

-

Issuance of common shares to vendor

 

135,000

 

-

 

256

 

-

 

-

 

256

Issuance of common stock and warrants in private placement

 

10,162,000

 

1

 

24,637

 

-

 

-

 

24,638

Issuance costs related to common stock and warrants in private placement

 

-

 

-

 

(2,454)

 

-

 

-

 

(2,454)

Foreign currency translation adjustment

 

-

 

-

 

-

 

115

 

-

 

115

Net loss

 

-

 

-

 

-

 

-

 

(14,429)

 

(14,429)

Balance at September 30, 2021

25,541,809

3

89,831

(1,365)

(72,375)

16,094

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

6

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)

(in thousands)

Nine Months Ended September 30, 

2021

    

2020

Cash flows from operating activities:

  

 

  

Net loss

$

(14,429)

$

(21,700)

Adjustments to reconcile net loss to net cash used in operating activities:

 

  

 

  

Depreciation

 

147

 

148

Common shares issued to vendor for services

 

186

 

Amortization of right of use asset

 

164

 

131

Stock-based compensation

6,097

Non-cash interest expense

 

 

6,835

Change in fair value of embedded conversion feature

 

 

6,282

Loss on conversion of convertible notes payable

 

 

5,470

Change in operating assets and liabilities:

 

 

  

Accounts receivable, net

 

19

 

(1)

Research & development tax credit receivable

 

46

 

871

Prepaid expenses and other current assets

 

(614)

 

(44)

Accounts payable and accrued expenses

 

478

 

(466)

Lease liabilities

 

(196)

 

(118)

Other assets

 

2

 

(1)

Net cash used in operating activities

 

(8,100)

 

(2,593)

Cash flows from investing activities:

 

  

 

  

Purchases of property, plant and equipment

 

(282)

 

(90)

Net cash used by investing activities

 

(282)

 

(90)

Cash flows from financing activities:

 

  

 

  

Proceeds from Credit Facility Loan Payable

 

738

 

Repayment of Credit Facility Loan Payable

(738)

Proceeds from the issuance of common stock

4,592

Proceeds from the issuance of common stock and warrants in private placement

 

24,638

Payment of issuance costs

 

(2,454)

Proceeds from the exercise of stock options

 

20

 

Net cash provided by financing activities

 

22,204

 

4,592

Effect of exchange rate changes on cash

 

133

 

(116)

Net change in cash

 

13,822

 

1,909

Cash, beginning of period

 

764

 

412

Cash, end of period

$

14,719

$

2,205

Supplemental disclosure of cash and non-cash investing and financing activities

 

  

 

  

Cash paid for income taxes

$

$

Cash paid for interest

$

19

$

Right of use asset and lease liability additions

$

86

$

Issuance of common shares for consulting services

$

99

$

Conversion of debt and accrued interest into common shares

$

$

25,759

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

7

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1.    BUSINESS AND LIQUIDITY

Organization & Reverse Recapitalization

SmartKem Inc. (“SmartKem” or the “Company”) a Delaware corporation, formerly known as Parasol Investments Corporation (“Parasol”), was formed on May 13, 2020 and is the successor, as discussed below, of SmartKem Limited, which was formed under the Laws of England and Wales. The Company was founded as a “shell” company registered under the Exchange Act, with no specific business plan or purpose until it began operating the business of SmartKem Limited following the closing of the Exchange described below.

On February 23, 2021 Parasol entered into a Securities Exchange Agreement (“the Exchange Agreement”), with SmartKem Limited. Pursuant to the Exchange Agreement all of the equity interests in SmartKem Limited, except certain deferred shares which had no economic or voting rights (the “Deferred Shares”) and which were purchased by Parasol for an aggregate purchase price of $1.40, were exchanged for shares of Parasol common stock, par value $0.0001 per share (“common stock”), and SmartKem Limited became a wholly owned subsidiary of Parasol (the “Exchange”).

As a result of the Exchange, Parasol acquired the business of SmartKem Limited, and continues as the existing business operations of SmartKem Limited as a public reporting company under the name SmartKem, Inc.

Under ASC 805, Business Combinations, SmartKem Limited was deemed the accounting acquirer based on the following predominate factors: Parasol was created as a “shell” company to effect a business combination and had no operations, the former shareholders of SmartKem Limited own more than a majority of the outstanding voting stock of the Company, the Company’s board of directors and management consists of the former board of directors and management of SmartKem Limited, SmartKem Limited was the largest entity by assets at the time of the Exchange, and the principal operating location of the Company is SmartKem Limited’s premises which are located in Manchester, United Kingdom.

The Exchange was accounted for as a reverse recapitalization, with no goodwill or other intangible assets recorded, in accordance with U.S. GAAP. Under this method of accounting, Parasol was treated as the “acquired” company for financial reporting purposes. Accordingly, for accounting purposes, the Exchange was treated as the equivalent of SmartKem Limited issuing stock for the net assets of Parasol, accompanied by a recapitalization. The net assets of Parasol are stated at historical cost, with no goodwill or other intangible assets recorded. The consolidated assets, liabilities, and results of operations prior to the Exchange are those of SmartKem Limited. Reported shares and earnings per share available to holders of the Company’s common stock, prior to the Exchange, have been retroactively restated as shares reflecting the exchange ratios established in the Exchange.

At the closing of the Exchange (the “Closing”), each SmartKem Limited ordinary share issued and outstanding immediately prior to the Closing (other than the Deferred Shares) was exchanged for 0.0111907 of a share of the Company’s common stock and each SmartKem Limited A ordinary share issued and outstanding immediately prior to the Closing was exchanged for 0.0676668 of a share of the Company’s common stock, with the maximum number of shares of our common stock issuable to the former holders of SmartKem Limited’s ordinary shares and A ordinary shares equal to 12,725,000. This includes enterprise management incentive options to purchase 124,497,910 SmartKem Limited ordinary shares (the “SmartKem Limited EMI Options”) issued and outstanding immediately prior to the Closing that were accelerated and exercised by the holders thereof for a like number of ordinary shares and exchanged for shares of the Company’s common stock pursuant to the Exchange. In aggregate 1,127,720,477 SmartKem Ltd shares were exchanged for 12,725,000 of the Company’s common stock, an average exchange ratio of 0.011283825. Immediately prior to the Closing, an aggregate of 2,500,000 shares of the Company’s common stock owned by the stockholders of Parasol prior to the Exchange were forfeited and cancelled (the “Stock Forfeiture”).

8

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Business

SmartKem, Inc. is seeking to reshape the world of electronics with a revolutionary semiconductor platform that enables a new generation of displays, sensors and logic. SmartKem’s patented TRUFLEX® inks are solution deposited at a low temperature, on low-cost substrates to make organic thin-film transistor (OTFT) circuits. The company’s semiconductor platform can be used in a number of applications including mini-LED displays, AMOLED displays, fingerprint sensors and logic circuits. SmartKem develops its materials at its research and development facility in Manchester, UK and its semiconductor manufacturing process at the Centre of Process Innovation (CPI) in Sedgefield, UK. The company has an extensive IP portfolio including approximately 120 issued patents.

Liquidity and Going Concern

The accompanying condensed consolidated financial statements have been presented on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has financed its activities principally from the issuance of its equity securities.

In March 2020, the World Health Organization declared the outbreak of COVID-19 as a global pandemic (the “Pandemic”). The Pandemic has had a widespread and detrimental effect on the global economy and has adversely impacted the Company’s business and results of operations. The Company has experienced travel bans, states of emergency, quarantines, lockdowns, “shelter in place” orders, business restrictions and shutdowns in the countries where it operates. The Company’s containment measures have impacted its day-to-day operations and disrupted its business. Because the severity, magnitude and duration of the Pandemic and its economic consequences are highly uncertain, rapidly changing and difficult to predict, the ultimate impact of the Pandemic on the Company’s business, financial condition and results of operations is currently unknown. The additional costs incurred by the Company related to COVID-19 for three and nine months ended September 30, 2021 were deemed to be immaterial to the financial statements. The Company anticipates there may be additional costs relating to the Pandemic incurred in the upcoming months that will be attributable to fiscal year 2021 and thereafter. These costs are not expected to be material.

The Company has incurred substantial and negative cash flows from operations in every fiscal period since inception. For three and nine months ended September 30, 2021, the Company incurred a net loss of $2.7 million and $14.4 million, respectively, and used $8.1 million in cash to fund operations for the nine months ended September 30, 2021 and had an accumulated deficit of $72.4 million as of September 30, 2021. The Company’s cash as of September 30, 2021 was $14.7 million.

Management believes that the existing cash at September 30, 2021 will be sufficient to fund operations for at least the next twelve months following the issuance of these unaudited condensed consolidated financial statements.

The consolidated entity presented is referred to herein as “SmartKem”, “we”, “us”, “our”, or the “Company”, as the context requires and unless otherwise noted.

9

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Basis for Presentation

These unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission and accounting principles generally accepted in the United States (“U.S. GAAP”) for interim reporting and are presented in thousands, except number of shares and per share data. Accordingly, certain notes or other information that are normally required by U.S. GAAP have been omitted if they substantially duplicate the disclosures contained in the Company’s annual audited consolidated financial statements. Accordingly, the unaudited condensed consolidated financial statements should be read in connection with the Company’s audited financial statements and related notes as of and for the year ended December 31, 2020. The accompanying condensed consolidated financial statements are unaudited; however, in the opinion of management, they include all normal and recurring adjustments necessary for a fair presentation of the Company’s unaudited condensed consolidated financial statements for the periods presented. Results of operations reported for interim periods are not necessarily indicative of results for the entire year.

Basis of Consolidation

The condensed consolidated financial statements include the accounts of SmartKem, Inc. and its wholly-owned subsidiaries, SmartKem Delaware, Inc. and SmartKem Limited. The Company does not have any nonconsolidated subsidiaries. All intercompany balances and transactions have been eliminated on consolidation, including unrealized gains and losses on transactions between the companies.

The dissolution of the Company's wholly-owned subsidiary, SmartKem Delaware Inc., was authorized by the Board of Directors and Stockholders on April 28, 2021. SmartKem Delaware, Inc. was dissolved on May 13, 2021.

Comprehensive loss

Comprehensive loss of all periods presented is comprised primarily of net loss and foreign currency translation adjustments.

Management’s Use of Estimates

The preparation of condensed consolidated financial statements in conformity U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, including disclosure of contingent assets and liabilities, at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The most significant estimates in the Company’s condensed consolidated financial statements relates to the valuation of common share, fair value of share options, fair value of embedded conversion features in the convertible notes, and the valuation allowance of deferred tax assets. These estimates and assumptions are based on current facts, historical experience and various other factors believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of expenses that are not readily apparent from other sources. Due to the uncertainty of factors surrounding the estimates or judgments used in the preparation of the financial statements, actual results may materially vary from these estimates.

Certain Risk and Uncertainties

The Company’s activities are subject to significant risks and uncertainties including the risk of failure to secure additional funding to properly execute the Company’s business plan. The Company is subject to risks that are common to companies in the growth stage, including, but not limited to, development by the Company or its competitors of new

10

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

technological innovations, dependence on key personnel, reliance on third party manufacturers, protection of proprietary technology, and compliance with regulatory requirements.

The Company has access under a framework agreement to equipment which is used in the manufacturing of demonstrator products employing the Company’s inks. If the Company lost access to this fabrication facility, it would materially and adversely affect the Company’s ability to manufacture prototypes and demonstration products for potential customers. The loss of this access could significantly impede the Company’s ability to engage in product development and process improvement activities. Alternative providers of similar services exist, but would take effort and time to bring into the Company’s operations.

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with original maturities of 90 days or less at acquisition to be cash equivalents. As of September 30, 2021 and December 31, 2020, the Company did not have any cash equivalents.

Accounts Receivable

Accounts receivable are stated at the amount the Company expects to collect and do not bear interest. The Company considers the following factors when determining the collectability of specific customer accounts: customer credit-worthiness, past transaction history with the customer, current economic industry trends, and changes in customer payment terms. These receivables have historically been paid timely. Due to the nature of the accounts receivable balance, the Company believes there is no significant risk of non-collection. If the financial condition of the Company’s customers were to deteriorate, adversely affecting their ability to make payments, allowances for doubtful accounts would be required. There was no allowance for doubtful accounts recorded as of September 30, 2021 and December 31, 2020.

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents and accounts receivable. Periodically, the Company maintains deposits in financial institutions in excess of government insured limits. Management believes that the Company is not exposed to significant credit risk as the Company’s deposits are held at financial institutions that management believes to be of high credit quality and the Company has not experienced any losses in these deposits.

Property, Plant and Equipment

Property, plant and equipment is stated at cost, less accumulated depreciation. Maintenance and repairs are expensed when incurred. Additions and improvements that extend the economic useful life of the asset are capitalized and depreciated over the remaining useful lives of the assets. The cost and accumulated depreciation of assets sold or retired are removed from the respective accounts, and any resulting gain or loss is reflected in current earnings. Depreciation and amortization are provided using the accelerated declining balance method in amounts considered to be sufficient to amortize the cost of the assets to operations over their estimated useful lives. Property, plant and equipment is depreciated at 25 percent of net book value on an annual basis, resulting in an estimated useful life of approximately 15 years.

Impairment of Long-Lived Assets

Management continually evaluates whether events or changes in circumstances might indicate that the remaining estimated useful life of long-lived assets may warrant revision, or that the remaining balance may not be recoverable. When factors indicate that long-lived assets should be evaluated for possible impairment, the Company uses an estimate

11

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

of the related undiscounted cash flows in measuring whether the long-lived asset should be written down to fair value. Measurement of the amount of impairment would be based on generally accepted valuation methodologies, as deemed appropriate. If the carrying amount is greater than the undiscounted cash flows, the carrying amount of the asset is reduced to the asset’s fair value. An impairment loss is recognized immediately as an operating expense in the condensed consolidated statements of operations. Reversal of previously recorded impairment losses are prohibited. As of September 30, 2021 and December 31, 2020, Company’s management believed that no revision to the remaining useful lives or impairment of the Company’s long-lived assets was required.

Derivative Asset for Embedded Conversion Features

The Company does not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks.

The Company evaluates convertible notes to determine if those contracts or embedded components of those contracts qualify as derivatives to be accounted for separately. In circumstances where the embedded conversion option in a convertible instrument is required to be bifurcated and there are also other embedded derivative instruments in the convertible instrument that are required to be bifurcated, the bifurcated derivative instruments are accounted for as a single, compound derivative instrument. The result of this accounting treatment is that the fair value of the embedded derivative is recorded as a liability and marked-to-market each balance sheet date, with the change in fair value recorded in the statements of operations as other income or expense. Upon conversion or exercise of a derivative instrument, the instrument is marked to fair value at the conversion date and then that fair value is reclassified to equity.

The fair value of the embedded conversion features are estimated using a Monte Carlo simulation model, in which possible outcomes and their values are simulated repeatedly and randomly. Under the Monte Carlo method the Company estimated the fair value of the convertible notes conversion feature at the time of issuance and subsequent remeasurement dates, utilizing the with-and without method, where the value of the derivative feature is the difference in values between a note simulated with the embedded conversion feature and the value of the same note simulated without the embedded conversion feature. Estimating fair values of embedded conversion features requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors.

Convertible Notes

The Company accounts for its convertible notes in accordance with ASC 470-20, Debt with Conversion and Other Options (“ASC 470-20”), which requires the liability and equity components of convertible debt instruments to be separately accounted for in a manner that reflects the issuer’s nonconvertible debt borrowing rate.

Debt discount created by the bifurcation of embedded feature in the convertible notes are reflected as a reduction to the related debt liability. The discount is amortized to interest expense over the term of the debt using the effective-interest method.

Warrants

The accounting treatment of warrants issued is determined pursuant to the guidance provided by ASC 480, Distinguishing Liabilities from Equity, and ASC 815, Derivatives and Hedging, as applicable. Each feature of a freestanding financial instruments including, without limitation, any rights relating to subsequent dilutive issuance, dividend issuances, equity sales, rights offerings, forced conversions, dividends, and exercise are assessed with determinations made regarding the proper classification in the Company’s consolidated financial statements. The Company determined that all outstanding warrants meet the criteria to be classified as equity.

12

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Leases

Operating lease assets are included within operating lease right-of-use assets, and the corresponding operating lease obligation on the unaudited condensed consolidated balance sheets as of September 30, 2021 and December 31, 2020. The Company has elected not to present short-term leases as these leases have a lease term of 12 months or less at lease inception and do not contain purchase options or renewal terms that the Company is reasonably certain to exercise. All other lease assets and lease liabilities are recognized based on the present value of lease payments over the lease term at commencement date. Because most of the Company’s leases do not provide an implicit rate of return, the Company used an incremental borrowing rate based on the information available at adoption date in determining the present value of lease payments.

Revenue

The Company applies the provisions of ASC 606 Revenue from Contracts with Customers. The Company recognizes revenue under the core principle to depict the transfer of control to the Company’s customers in an amount reflecting the consideration the Company expects to be entitled to. In order to achieve that core principle, the Company applies the following five step approach: (1) identify the contract with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contact and (5) recognize revenue when a performance obligation is satisfied.

The Company’s current contracts with customers do not contain significant estimates or judgments. All of the Company’s revenue contains a single performance obligation that is recognized upon fulfilment of the sales order.

The Company derives its revenues primarily from sales of demonstrator units to customers evaluating organic semiconductor technology. The transaction price is stated in each customer agreement and is allocated to a single performance obligation. Revenue is recognized upon shipment of each demonstrator, at a point in time. The Company does not have any significant financing components as payment is received at or shortly after the point of sale. Costs incurred to obtain a contract will be expenses as incurred when the amortization period is less than a year.

Research and Development Expenses

The Company expenses research and development costs as incurred. Research and development costs include salaries, employee benefit costs, direct project costs, supplies and other related costs. Advance payments for goods and services that will be used in future research and development activities are expensed when the activity has been performed or when the goods have been received.

Patent and Licensing Costs

Patent and licensing costs are expensed as incurred because their realization is uncertain. These costs are classified as research and development expenses in the accompanying condensed consolidated statements of operations and comprehensive loss.

Other Operating Income

The Company’s other operating income is related to government grant incentives received for qualifying research and development projects, and research and development tax credits related to the United Kingdom’s Research and Development Expenditure Credit scheme, which is a government tax incentive designed to reward innovative companies for investing in research and development. Such incentives are recorded as other income when it is probable the amounts are collectible and can be reasonably estimated.

13

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

For the three months ended September 30, 2021 and 2020, the Company recorded grant income and research & development tax credits of $447 thousand and $747 thousand, respectively, and $1,135 thousand and $1,125 thousand for the nine months ended September 30, 2021 and 2020, respectively which are recorded as other operating income in the accompanying condensed consolidated statements of operations. As of September 30, 2021, and December 31, 2020, the Company had receivables related to research & development tax credits for payments not yet received of $921 thousand and $982 thousand, respectively.

Share-based compensation

All share-based payments, including grants of stock options, are measured based on the fair value of the share-based awards at the grant date and recognized over their respective vesting periods. Outstanding options generally expire 10 years after the grant date. The Company has issued options that vest based on service requirements and issued options that vest based on performance requirements. Options become exercisable when service requirements are met. In the case of performance based options, options become exercisable when there is a liquidity event, such as a change in control or sale or admission (listing as a public company or initial public offering (“IPO”)), and the employee, or consultant, must be providing services to the Company at the time of the event. Due to the Exchange, all options outstanding immediately prior to the event with a performance obligation requirement became vested and exercisable.

The estimated fair value of stock options at the grant date is determined using the Black-Scholes pricing model. The Black-Scholes option pricing model requires inputs such as the fair value of common stock on date of grant, expected term, expected volatility, dividend yield, and risk-free interest rate. The assumptions used in calculating the fair value of stock-based awards represent management’s best estimates and involve inherent uncertainties and the application of management’s judgment. As a result, if factors change and management uses different assumptions, stock-based compensation expense could be materially different for future awards. The Company records forfeitures when they occur.

Functional Currency and Operations

Prior to the Exchange, SmartKem Limited’s (“the predecessor’s”) functional currency was the British Pound Sterling (“GBP”), and the consolidated financial statements were presented in United States dollars (“USD”).  The predecessor’s functional currency was the respective local currency of the primary economic environment in which an entity’s operations are conducted. The predecessor translated the financial statements into the presentation currency using exchanges rates in effect on the balance sheet date for assets and liabilities and average exchanges rates for the period for statement of operations accounts, with the difference recognized in accumulated other comprehensive income (loss).

From the date of the Exchange forward, the Company’s functional currency is the U.S. dollar (“USD”). The functional currency of the Company’s foreign operation is the respective local currency. Assets and liabilities of foreign operation denominated in local currencies are translated at the spot rate in effect at the applicable reporting date. The condensed consolidated statements of operations and comprehensive loss are translated at the weighted average rate of exchange during the applicable period. The resulting unrealized gain/loss is recognized as foreign currency translation as a component of other comprehensive income.  

Income Taxes

Income taxes are recorded in accordance with ASC 740, Income Taxes (“ASC 740”), which provides for deferred taxes using an asset and liability approach. The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are

14

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

provided, if based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

The Company accounts for uncertain tax positions in accordance with the provisions of ASC 740. When uncertain tax positions exist, the Company recognizes the tax benefit of tax positions to the extent that the benefit would more likely than not be realized assuming examination by the taxing authority. The determination as to whether the tax benefit will more likely than not be realized is based upon the technical merits of the tax position as well as consideration of the available facts and circumstances. The Company recognizes any interest and penalties accrued related to unrecognized tax benefits as income tax expense.

As of September 30, 2021 and December 31, 2020, there were no accruals for uncertain tax positions.

Contingent Liabilities

A provision for contingent liabilities is recorded when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. With respect to legal matters, provisions are reviewed and adjusted to reflect the impact of negotiations, estimated settlements, legal rulings, advice of legal counsel and other information and events pertaining to a particular matter. The Company is a party to certain litigation and disputes arising in the normal course of business. As of September 30, 2021, the Company does not expect that such matters will have a material adverse effect on the Company’s business, financial position, results of operations, or cash flows.

Offering Costs

Direct and incremental legal and accounting costs associated with the Company’s issuance of common stock and warrants are deferred and classified as a component of other assets on the consolidated balance sheet until completion of the issuance. Upon completion of the issuance, deferred offering costs are reclassified from other assets to equity and recorded against the net proceeds received in the issuance. The deferred offering costs incurred as of December 31, 2020 were immaterial and no offering costs were capitalized. For the nine months ended September 30, 2021 $2,454 thousand of offering costs were recorded in additional paid-in capital.

Segment Information

The Company has determined that it operates and reports in one segment, which focuses on the development of materials and processes used to make organic thin-film transistors (OTFTs) for the manufacture of flexible electronics. The Company’s operating segment is reported in a manner consistent with the internal reporting provided to the chief operating decision maker (“CODM”). The Company’s CODM has been identified as its Chairman and Chief Executive Officer.

Basic and Diluted Loss Per Share

Basic and diluted net loss per share is determined by dividing net loss by the weighted average ordinary shares outstanding during the period. For all periods presented with a net loss, the shares underlying the ordinary share options and warrants have been excluded from the calculation because their effect would be anti-dilutive. Therefore, the weighted-average shares outstanding used to calculate both basic and diluted loss per share are the same for periods with a net loss.

The loss per share information in these condensed consolidated financial statements is reflected and calculated as if the Company had existed since January 1, 2020. Accordingly, loss per share for all periods was calculated based on the number of shares retroactively adjusted for the exchange ratio determined in the reverse recapitalization (see also note 1).

 

15

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The Company has 2,168,000 pre-funded common stock warrants outstanding as of September 30, 2021, which became exercisable on April 23, 2021 based on terms and conditions of the agreements. As the pre-funded common stock warrants are exercisable for $0.01, these shares are considered outstanding common shares and included in computation of basic and diluted Earnings Per Share as the exercise of the pre-funded common stock warrants is virtually assured. The Company included these pre-funded common stock warrants in basic and diluted earnings per share when all conditions were met on April 23, 2021.

The following potentially dilutive securities have been excluded from the computation of diluted weighted average shares outstanding as they would be anti-dilutive:

September 30, 

    

2021

    

2020

Options

2,036,882

1,681,239

Warrants

 

985,533

 

Total

3,022,415

1,681,239

Recent Accounting Pronouncements

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments: Credit Losses (Topic 326), which requires measurement and recognition of expected losses for financial assets held. The new standard changes the impairment model for most financial instruments, including trade receivables, from an incurred loss method to a new-forward looking approach, based on expected losses. The estimate of expected credit losses will require organizations to incorporate considerations of historical information, current conditions and reasonable and supportable forecasts. The standards update is effective prospectively for annual and interim periods in fiscal years beginning after December 15, 2019, with early adoption permitted, for U.S. Securities Exchange filer, excluding entities eligible to be smaller reporting companies. The standards update is effective prospectively for annual and interim periods beginning after December 15, 2022. Management is currently evaluating the impact of these changes on the Financial Statements.

In May 2021, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2021-04, Earnings Per Share (Topic 260), Debt—Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40). The amendments in this update affect all entities that issue freestanding written call options (for example warrants) that are classified in equity. Specifically, the amendments affect those entities when a freestanding equity-classified written call option is modified or exchanged and remains equity classified after the modification or exchange. The amendments that relate to the recognition and measurement of EPS for certain modifications or exchanges of freestanding equity-classified written call options affect entities that present EPS in accordance with the guidance in Topic 260, Earnings Per Share. The amendments in this update are effective for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. Management is currently evaluating the impact of this guidance but does not expect this update to have a material impact on the Company's financial statements.

16

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

3.    PREPAID EXPENSES AND OTHER CURRENT ASSETS:

Prepaid expenses and other current assets consist of the following:

September 30, 

December 31, 

    

2021

    

2020

Prepaid rent

$

77

$

65

Prepaid utilities

 

30

 

30

Prepaid insurance

 

557

 

41

Prepaid administrative expenses

 

101

 

69

Prepaid consulting fees

80

VAT receivable

 

92

 

54

Total prepaid expenses and other current assets

$

937

$

259

As of September 30, 2021 and December 31, 2020, there was $226 thousand and $0, respectively, of non-current prepaid insurance related to directors’ and officers’ liability insurance that was included in the amounts above.  

4.    PROPERTY, PLANT AND EQUIPMENT:

Property, plant and equipment consist of the following:

September 30, 

December 31, 

    

2021

    

2020

Plant and equipment

$

1,575

$

1,316

Furniture and fixtures

 

245

 

248

Computer hardware and software

 

26

 

26

 

1,846

 

1,590

Less: Accumulated depreciation

 

(1,041)

 

(908)

Property, plant and equipment, net

$

805

$

682

Depreciation expense was $52 thousand and $50 thousand for three months ended September 30, 2021 and 2020, respectively, and $147 thousand and $148 thousand for the nine months ended September 30, 2021 and 2020, respectively, and is classified as research and development expense.

17

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

5.    ACCOUNTS PAYABLE AND ACCRUED EXPENSES:

Accounts payable and accrued expenses consist of the following:

September 30, 

December 31, 

    

2021

    

2020

Accounts payable

$

506

$

227

Accrued expenses – lab refurbishments

 

131

 

132

Accrued expenses – technical fees

 

81

 

45

Accrued expenses – variable rent & utilities

 

13

 

67

Accrued expenses – audit & accounting fees

 

185

 

250

Accrued expenses – other

 

31

 

6

Credit card liabilities

 

21

 

6

Payroll liabilities

 

355

 

128

Total accounts payable and accrued expenses

$

1,323

$

861

6.    LEASES:

The Company has operating leases consisting of office space, lab space, and equipment with remaining lease terms of 1 to 2 years, subject to certain renewal options as applicable.

There was no sublease rental income for three and nine months ended September 30, 2021 and 2020. The Company is not the lessor in any lease agreement, and no related party transactions for lease arrangements have occurred.

The table below presents certain information related to the lease costs for the Company’s operating and finance leases for the periods ended:

For the Three Months Ended September 30, 

For the Nine Months Ended September 30, 

    

2021

    

2020

    

2021

    

2020

Operating lease cost

$

60

$

45

$

159

$

132

Short-term lease cost

 

3

 

2

 

29

 

15

Variable lease cost

 

7

 

95

 

105

 

221

Total lease cost

$

70

$

142

$

293

$

368

The total lease cost is included in the unaudited condensed consolidated statements of operations as follows:

For the Three Months Ended September 30, 

For the Nine Months Ended September 30, 

    

2021

    

2020

    

2021

    

2020

Research and development

$

64

$

130

$

271

$

336

Selling, general and administrative

 

6

 

12

 

22

 

32

Total lease cost

$

70

$

142

$

293

$

368

18

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Right of use lease assets and lease liabilities for our operating leases were recorded in the consolidated balance sheet as follows:

    

September 30, 

December 31, 

    

2021

    

2020

Assets

  

 

  

Operating lease right of use assets

$

170

$

236

Total lease assets

$

170

$

236

Liabilities

 

  

 

  

Current liabilities:

 

  

 

  

Operating lease liability – current portion

$

125

$

217

Noncurrent liabilities:

 

  

 

  

Operating lease liability, net of current portion

 

16

 

20

Total lease liabilities

$

141

$

237

The Company had no right of use lease assets and lease liabilities for financing leases as of September 30, 2021 and December 31, 2020.

The table below presents certain information related to the cash flows for the Company’s operating leases for the periods ended:

    

Nine Months Ended September 30,

    

2021

    

2020

Operating cash outflows from operating leases

$

196

$

118

Supplemental non-cash amounts of operating lease liabilities arising from obtaining right of use assets

$

86

$

The table below presents certain information related to the weighted average remaining lease term and the weighted average discount rate for the Company’s operating and finance leases as of the period ended:

    

September 30, 

    

2021

Weighted average remaining lease term (in years) – operating leases

0.89

 

Weighted average discount rate – operating leases

6.07

%  

19

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Undiscounted operating lease liabilities as of September 30, 2021, by year and in the aggregate, having non-cancelable lease terms in excess of one year were as follows:

    

As of 

September 30, 

2021

2021

$

73

2022

 

75

2023

 

8

2024

 

2025

 

Thereafter

 

Total undiscounted lease payments

 

156

Less imputed interest

 

(15)

Total net lease liabilities

$

141

7.    CONVERTIBLE NOTES AND NOTES PAYABLE:

Convertible Notes

On January 24, 2020, a Qualified Financing Event (as defined below) occurred when the Company received cumulative investment proceeds in excess of $4,600 thousand from the sale and issuance of common shares. The fair value of the Company’s common shares were $1.807011 per share. The 2018 BASF Venture Capital and Entrepreneurs Fund L.P. Notes (as defined below), 2018 Octopus Investment Limited Notes (as defined below), and the 2019 Octopus, EF, and Other Notes (as defined below) in the aggregate principal amount of $11,796 thousand were converted into 8,159,977 of common shares (at the discounted price of $1.45 per share), and the related unpaid and accrued interest totaling $1,063 thousand were also converted into 735,148 of A Ordinary common shares of the Company (at the discounted price of $1.45 per share). The Company recognized a loss on conversion of $5,470 thousand for the nine months ended September 30, 2020 related to the conversion of notes measured as the difference in carrying value of debt and accrued interest and the fair value of shares converted on the conversion date. As a result of the conversion, the Company also recognized the unamortized debt discount related to the beneficial conversion feature of $6,767 thousand as interest expense for the nine months ended September 30, 2020.

For the nine months ended September 30, 2020, the Company incurred an effective interest rate of 13.5% relating to convertible notes. There were no convertible notes outstanding during the three months ended September 30, 2020 and the three and nine months ended September 30, 2021. There was interest expense recognized based on the debt’s stated interest for the nine months ended September 30, 2021 and 2020 of zero and $43 thousand, respectively, relating to convertible notes. Additional interest expense related to the amortization of debt issuance cost was zero and $25 thousand for the nine months ended September 30, 2021 and 2020, respectively, for convertible notes. There was no interest expense or amortization of debt issuance cost recognized relating to convertible notes for the three months ended September 30, 2021 and 2020,

Loss on the conversion of notes is included on the consolidated statements of operations and other comprehensive loss as loss on conversion of convertible notes payable. The amount displayed in the statements of operations and other comprehensive loss for the three months ended September 30, 2020 is inclusive of the loss on notes in the amount of $9,344 thousand, loss on accrued interest in the amount of $1,046 thousand and offset by the gain on the extinguishment of derivative liability in the amount of $4,920 thousand (Note 8).

20

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

2018 BASF Venture Capital and Entrepreneurs Fund L.P. Notes

On April 18, 2018, the Company entered into a convertible note agreement (the “2018 BASF Venture Capital and Entrepreneurs Fund L.P. Notes”), with BASF Venture Capital (“BASF”) and Entrepreneurs Fund L.P. (“EF”) with an aggregate principal of $5,862 thousand. The 2018 BASF/EF Convertible Note was issued in three separate tranches on April 18, 2018, July 20, 2018, and December 28, 2018.

The 2018 BASF Venture Capital and Entrepreneurs Fund L.P. Notes and accrued but unpaid interest were convertible into the common share based on (i) fund raising at a price paid per Senior Share equal to the price paid per Senior Share by the investors on a Fund Raising at a discount to the per share price in the Fund Raising, (ii) sale of the company at a price per Senior Share of $16.39, or (iii) listing of the company on a publicly traded market at a price per Senior Share of $16.39. The principal amount shall accrue interest at a rate of 8% per annum, from the Issue Date up until the first anniversary of the Issue Date. Interest shall accrue on the principal amount at a rate of 15% per annum from, and including, the first anniversary of the Issue Date up until the notes are (i) converted, cancelled, repaid or redeemed or (ii) the longstop date. Accrued interest was to be calculated on the basis of a 365-day year for the actual number of days elapsed.

2018 Octopus Notes

On July 20, 2018 the Company entered into a convertible note agreement (the “2018 Octopus Investment Limited Notes”) with Octopus Investment Limited (“Octopus”) with an aggregate nominal amount of $2,622 thousand. The 2018 Octopus Convertible Note was issued in two separate tranches on July 20, 2018 and December 28, 2018.

The 2018 Octopus Notes and accrued but unpaid interest were convertible into the common shares based on (i) fund raising at a price paid per Senior Share equal to the price paid per Senior Share by the investors on a Fund Raising at a discount, (ii) sale of the company at a price per Senior Share of $15.10, or (iii) listing of the company on a publicly traded market at a price per Senior Share of $15.10. The principal amount shall accrue interest at a rate of 8% per annum, from the Issue Date up until the first anniversary of the Issue Date. Interest shall accrue on the principal amount at a rate of 12% per annum from, and including, the first anniversary of the Issue Date up until the notes are (i) converted, cancelled, repaid or redeemed or (ii) the longstop date. Accrued interest was to be calculated on the basis of a 365-day year for the actual number of days elapsed.

2019 Octopus, EF, and Other Notes

On June 26, 2019 the Company entered into a convertible note agreement (the “2019 Octopus, EF, and Other Notes”) with Octopus, EF, and various private investors with an aggregate nominal amount of $3,681 thousand. The 2019 Octopus Convertible Note was issued in two separate tranches on June 26, 2019 and September 23, 2019.

The 2018 Octopus, EF, and Other Notes and accrued but unpaid interest were convertible into the common shares based on (i) fund raising at a price paid per Senior Share equal to the price paid per Senior Share by the investors on a Fund Raising at a discount, (ii) sale of the company at a price per Senior Share of $0.001861, (iii) listing of the company on a publicly traded market at a price per Senior Share of $14.61, or (ii) any date following the first anniversary of the date the of the Instrument at a price per Senior Share of $11.19. The principal amount shall accrue interest at a rate of 10% per annum, from the Issue Date up until the notes are (i) converted, cancelled, repaid or redeemed or (ii) the longstop date. Accrued interest was to be calculated on the basis of a 365-day year for the actual number of days elapsed. The issuance of convertible notes with a beneficial redemption feature resulted in a debt discount of $2,608 thousand.

21

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Notes Payable

On January 26, 2021, the Company entered into a term loan facility agreement for the amount of $738 thousand. The funds were available to be drawn on from the effective date of the agreement through January 27, 2021. The Company drew down the full loan amount on January 26, 2021. The Company’s research and development tax credit was to be utilized as collateral. The Lender was to be paid immediately following payment of research and development tax credit from the United Kingdom’s HM Revenue and Customs. The final repayment was due six months from the agreement date, if the loan and any interest was not repaid in full prior to this date. The loan carried a monthly interest rate of 1.25%. The interest accrued daily and compounded monthly on the monthly anniversary of the draw down date of the loan.

For nine months ended September 30, 2021, the Company incurred an effective interest rate of 26.20% relating to notes payable. There were no notes payable outstanding during for the nine months ended September 30, 2020. The interest expense recognized based on the debt’s effective interest rate for nine months ended September 30, 2021 and 2020, was $19 thousand and zero, respectively, relating to notes payable. There were no notes payable outstanding during the three months ended September 30, 2021 and 2020, and no associated interest expense during the period.

The Company repaid the note payable in full on March 2, 2021. There were no notes payable outstanding as of September 30, 2021 and December 31, 2020.

8.    DERIVATIVE ASSET:

The company recorded a derivative asset related to the convertible notes outstanding during the nine months ended September 30, 2020. The Company measured the derivative asset on a recurring basis using significant unobservable inputs (Level 3) for nine months ended September 30, 2020.

The Embedded Conversion Features are separately measured at fair value, with changes in fair value recognized in current operations. The original values of the Embedded Conversion Features were recorded as a derivative asset with the offset as a debt premium to the Convertible Notes which is being amortized over the term of the Convertible Notes. During the nine months ended September 30, 2020, all outstanding convertible notes were converted into equity. The derivative asset was marked to market on the date of conversion and derecognized at conversion. The change in fair value of derivative asset included in earnings was $6,282 thousand for the nine months ended September 30, 2020. The gain on extinguishment of derivative asset upon conversion is $4,920 thousand and is recorded as an offset within the loss on conversion of convertible notes payable on the consolidated statements of operations and comprehensive loss.

There were no convertible notes outstanding during the three and nine months ended September 30, 2021, and no associated derivative asset during the period.

9.    COMMITMENTS AND CONTINGENCIES:

Legal proceedings

In the normal course of business, the Company may become involved in legal disputes regarding various litigation matters. In the opinion of management, any potential liabilities resulting from such claims would not have a material effect on the financial statements.

22

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

10.    STOCKHOLDERS’ EQUITY:

Common Stock

Voting Rights

Each holder of common stock is entitled to one vote for each share on all matters submitted to a vote of the stockholders, including the election of directors. The Company’s amended and restated certificate of incorporation and the Company’s amended and restated bylaws do not provide for cumulative voting rights. The holders of one-third of the stock issued and outstanding and entitled to vote, present in person or represented by proxy, shall constitute a quorum for the transaction of business at all meetings of the stockholders.

Dividends

The Company has never paid any cash dividends to shareholders and do not anticipate paying any cash dividends to shareholders in the foreseeable future. Any future determination to pay cash dividends will be at the discretion of our board of directors and will be dependent upon financial condition, results of operations, capital requirements and such other factors as the board of directors deems relevant.

Market Information

The Company’s common stock is not listed on a national securities exchange, an over-the-counter market or any other exchange. Therefore, there is no trading market, active or otherwise, for our common stock and the Company’s  common stock may never be included for trading on any stock exchange, automated quotation system or any over-the-counter market.

Preferred Stock

The Company currently has no shares of preferred stock outstanding, and the Company has no present plan to issue any shares of preferred stock. The board of directors has the authority, without further action by the stockholders, to issue up to 10,000,000 shares of preferred stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof. These rights, preferences, and privileges could include dividend rights, conversion rights, voting rights, redemption rights, liquidation preferences, sinking fund terms, and the number of shares constituting any series or the designation of such series, any or all of which may be greater than the rights of common stock.

Common Stock Warrants

On Februar